PRICE

DISCRIMINATIO
N
INTRODUCTION
Price Discrimination:
Price discrimination is a pricing strategy where a seller charges different
prices for the same product or service to different customers based on their willingness to pay,
quantity purchased, or specific customer characteristics. This approach aims to maximize revenue
by capturing consumer surplus—the difference between what consumers are willing to pay and
what they actually pay. There are three types of price discrimination – first-degree,
second-degree, and third-degree price discrimination.

 Same Product (Homogenous Product)

Assumptions:

Price discrimination exists when the same product is sold at different prices to different buyers.

The cost of production is either the same, or it differs but not as much as the difference in the charged prices.

The product is basically the same, but it may have slight differences (for example, different binding of the same book; different
location of seats in a theatre; different seats in an aircraft or a train).

These factors give rise to demand curves with different elasticities in the various sectors of the market of a firm.

It is also common to charge different prices for the same product at different time periods.

The necessary conditions, which must be fulfilled for the implementation of price discrimination are the following:

1. The market must be divided into sub-markets with different price elasticities.
2. There must be effective separation of the sub-markets, so that no reselling can take place from a low-price market to a high-
price market. This condition shows why price discrimination is easier to apply with commodities like electricity or gas, and
services (like services of a doctor, transport, a show), which are 'consumed' by the buyer and cannot be resold.
Objective: The aim of a monopolist (or any firm) applying price discrimination is to increase total revenue and profits. By
charging different prices in different markets, the monopolist can make more money than by charging a single uniform price.
1.Demand Curves:
1. D1: More elastic (sensitive to price changes).
2. D2: Less elastic (less sensitive to price changes).
3. Total Demand (D): Combination of D1 and D2.
2.Marginal Revenue (MR):
1. Aggregate MR is the sum of MR from both markets (MR1 + MR2).
2. The marginal-cost (MC) curve represents the cost to produce one more unit.
3.Decision Making:
1. The monopolist decides the total output (quantity) to produce where MC intersects the aggregate MR.
2. The monopolist also decides how much to sell in each market and at what prices.
4.Output and Revenue:
1. Total output (OX) is determined by the intersection of MC and aggregate MR.
2. If a uniform price were charged, the monopolist would earn less revenue (OX AP) compared to using price
discrimination.
Here is a graphical representation of
the key points in the price
discrimination model:
•MC (Marginal Cost): Blue line
•MR1 (Marginal Revenue for
Market 1): Red dashed line
•MR2 (Marginal Revenue for
Market 2): Green dashed line
•MR Total (Combined Marginal
Revenue): Purple line
First-Degree Price Discrimination:
First-degree discrimination, or perfect price discrimination, occurs when a business charges the maximum possible price for
each unit consumed. Because prices vary among units, the firm captures all available consumer surplus for itself or the
economic surplus. Many industries involving client services practice first-degree price discrimination, where a company
charges a different price for every good or service sold.
Explanation:
The graph shows a classic example of first-degree price discrimination. Here, the firm charges each consumer the maximum price
they are willing to pay, capturing the entire consumer surplus as profit.
• Demand Curve (D): Represents the maximum price different consumers are willing to pay for each quantity.
• Points A, B, and C: Indicate different consumers paying different prices (P, P1, and P2) for different quantities (Q, Q1,
and Q2). Each consumer's willingness to pay decreases as the quantity increases.
• Consumer Surplus: The area under the demand curve and above the price line (triangle shaded in red) is captured by
the firm as profit.
Example:
Imagine a car dealership selling a limited edition car. Each buyer has a different maximum price they are willing to pay
based on their preferences and budget. The dealership negotiates with each buyer individually and sells the car at the highest price
each buyer is willing to pay. For example:
• Buyer 1: Willing to pay $50,000 for the car, and the dealership sells it to them at this price.
• Buyer 2: Willing to pay $45,000, and the dealership sells it to them at this price.
• Buyer 3: Willing to pay $40,000, and the dealership sells it to them at this price.
By charging each buyer their maximum willingness to pay, the dealership maximizes its profits and captures
all the consumer surplus.
This type of price discrimination is often seen in industries where personalized pricing is possible, such as car
sales, real estate, and certain luxury goods.
Second-Degree Price Discrimination:
Second-degree price discrimination occurs when a company charges a different price for different
quantities consumed, such as quantity discounts on bulk purchases.
Explanation:
The graph illustrates second-degree price discrimination, where the firm charges different prices per unit depending on the
quantity consumed. Consumers are segmented based on the quantity they purchase, with lower prices offered for larger quantities.
•Demand Curve: Shows the relationship between price and quantity demanded.
•Price Points P1P_1P1​and P2P_2P2​: Different prices are set for different quantity levels.
• P1P_1P1​is the higher price for the first segment (up to Q1Q_1Q1​).
• P2P_2P2​is the lower price for the second segment (from Q1Q_1Q1​to Q∗Q^*Q∗).
•Quantities Q1Q_1Q1​and Q2Q_2Q2​:
• Q1Q_1Q1​is the quantity at which the first price point P1P_1P1​is applicable.
• Q2Q_2Q2​is the quantity at which the second price point P2P_2P2​is applicable.
•Consumer Segments:
• Segment A (up to Q1Q_1Q1​): Consumers pay a higher price P1P_1P1​.
• Segment B (from Q1Q_1Q1​to Q∗Q^*Q∗): Consumers pay a lower price P2P_2P2​.
The areas in the graph:
•Red Area: Represents the revenue from consumers who buy up to Q1Q_1Q1​at price P1P_1P1​.
•Green Area: Represents the additional revenue from consumers who buy between Q1Q_1Q1​and Q∗Q^*Q∗ at price P2P_2P2​.
Example:
A common example of second-degree price discrimination is bulk pricing in retail. For instance, consider a grocery store selling
laundry detergent:
•Single Unit Price: A single bottle of detergent is sold for $10 each.
•Bulk Price: If a customer buys three bottles, the price drops to $8 per bottle.
Here’s how the pricing works:
•Consumers buying 1-2 bottles: Pay $10 each.
•Consumers buying 3 or more bottles: Pay $8 each.
This encourages customers to buy more to benefit from the lower per-unit price, thus increasing the store’s total revenue. The
store segments its market based on the quantity purchased, capturing different levels of consumer surplus.